MMP Blog #36 What Government Ought to Do: An Introduction

In the nextseries of blogs we will turn to whatgovernment ought to do. This serieswill specifically treat only sovereign government—one that issues its owncurrency. From the earlier blogs, that will make it clear that we areaddressing only a government that does not face an affordability constraint.

In theseupcoming blogs we will examine alternative views about the proper role forgovernment—given that it can “afford” anything for sale in its own currency. Wefirst look at four reasons why government spending ought to be constrained. Wethen compare and contrast a typical “conservative” versus “liberal” view aboutthe scope of government. (These terms are used in the American sense—that are somewhatidiosyncratic. In America, conservative is closer to what is called “liberal”or “neoliberal” abroad. Liberal in America is closer to “social democratic” orto “labor party” abroad.)

We willwork toward developing an example of a government program that is consistentwith the MMT view of sovereign money—one that uses the principles we haveestablished in previous chapters to resolve the problem of unemployment in amanner that is consistent with both the liberal and the conservative views.That is the employer of last resort or job guarantee approach. I will concludethis series with my own view on whether MMT must include the ELR/JG proposal.

Warning:when we address views on whatgovernment ought to do, we have moved beyond description. My views of what government ought to do need not beaccepted by others, even those who fully understand MMT. I will be makingpolicy recommendations that are consistent with MMT. You do not have to likemine; you can come up with your own. I will devote a blog to an Austrianapproach to policy-making, and its goals will be different from my own.

Just Because Government Can Afford to Spend, Does Not MeanGovernment Ought to Spend. Understanding how government spends leads to the conclusion that affordability is not really theissue—government can always affordthe “keystrokes” necessary to make expenditures as desired. But that does notmean it should. We can list severallegitimate reasons for constraining government spending:

too much spending can causeinflation

too much spending couldpressure the exchange rate

too much spending by government might leave too few resources forprivate interests

government should not do everything—impactson incentives could be perverse

budgeting provides a lever to manage and evaluate government projects

Forexample, suppose government decides to newly hire 1000 rocket scientists for anexpedition to Pluto. Our first consideration is whether there are 1000 rocket scientists available forhire with the necessary skills. Even if government can afford its desired spending plan that does not mean it canaccomplish its mission if the resources are not available. In other words, thegovernment always faces a “real resource” constraint: do the resources exist,and are they for sale or hire? Related to this consideration: are the existinginfrastructure, technology, and knowledge up to the task of achieving programgoals. That, of course, is an important question. Let us presume that theseconditions are met.

The secondconsideration, then, concerns competition with alternative uses of theresources, what is called the “opportunity cost”. If those 1000 rocketscientists would otherwise be unemployed, then the opportunity cost of hiringthem for the Pluto mission is low or zero. (We might find, for example, that ifthey were not employed they would take care of their children at home so thenon-zero opportunity cost of employing them is the value of the foregonechildcare services. You get the picture—it is not likely that opportunity costsare zero, but for unemployed laborthey are probably low relative to benefits of employment in appropriate jobs.)

Moreimportantly, it is likely that many or most of them are already working, eitherin the private sector or on other government projects. Since sovereigngovernment does not face an affordability constraint, it can win a bidding waragainst the private sector if it chooses to do so. In that case, it will pushup the wages of rocket scientists so high that the private sector gives up andhires workers with other credentials. The impacts on the private sector couldbe complex—likely leading to higher wages, higher product costs, and even lessoutput in those sectors that use rocket scientists and other skilled workerswho can substitute to some degree for rocket scientists (perhaps for somepurposes, other types of engineers are almost as good, so firms bid up theirwages). At the very least, the Pluto mission could lead to“bottlenecks”—relative shortages of key resources—and some (perhaps limited)price hikes. In that case, public policy must consider the much greateropportunity cost of hiring rocket scientists away from other employment.

Inaddition, other wages and prices might be increased through spill-over effectsif a new government program is so big that it sets off a general bidding warfor labor and other resources. For example, during a major war like WWII,government not only conscripts workers into the military but it also redirectsresources to production for the war effort. Without rationing and wage andprice controls, it is relatively easy for this to lead to a general price andwage inflation. Note that it does not take a major war for this to happen. Ifgovernment spending pushes the economy to, and beyond, full employment it islikely that inflation will result even in the absence of a major war. At thesame time, high domestic employment and income can—under somecircumstances—lead to a trade deficit (as domestic demand for imports risesrelative to foreign demand for exports—discussed in the previous section). Thismight then pressure exchange rates (although the correlation between tradedeficits and exchange rate depreciation is far from certain).

Hence,while government can afford to spend more, it must weigh the consequences interms of withdrawing resources from other (perhaps more desirable) uses, aswell as possible impacts on prices and exchange rates.

There aremany other reasons to constrain government spending. For example, conservativesoften argue that spending on “welfare” affects incentives. A strong socialsafety net might send the signal that individuals do not really need to workbecause they can always live well enough on government hand-outs. Or,government bail-outs of business might encourage management to take excessiverisks on the belief that no matter what happens, government will cover thefirm’s losses.

Further, acorrupt government might spend on programs that help friends, but refuse to doanything to assist more deserving groups—what is often called “cronycapitalism”. So, there could be complexand even unintended consequences of government programs.

All of thatmust be considered when undertaking government spending programs—and negativeconsequences raise legitimate concerns about the size of government spending,not due to the (im)possibility of insolvency but rather to undesired (andunknown) effects of government programs.

Finally,governments should, and do, use budgets, which are a form of self-imposedconstraint. Typically, the elected representatives will allocate a sum to bespent on a particular project. Program managers are then held accountable forfinishing the project within the budgeted amount. Over-running the budget canbe used as an indication of mismanagement. The budgeting process also helps toreduce the incentive for “mission creep”, expanding the project to enhance themanager’s power and prestige. In other words, budgeting by sovereign governmentprovides a useful mechanism for project control and evaluation.

We concludethis section by observing that absence of an “affordability” constraint doesnot imply that government ought tospend without constraint. As we discuss in the next blog, its spending ought tobe aimed toward achieving the “public purpose”.